Please answer all 3 and show work, I am lost, thank you Page |5 3. A twenty-year
ID: 2787384 • Letter: P
Question
Please answer all 3 and show work, I am lost, thank you Page |5 3. A twenty-year bond with a 8% coupon rate and a face value of S 1000 makes semi-annual coupon payments. Required return for bonds of equivalent risk is 10%. Calculate the market value of the bond. (10 pt.) 4a. You are contemplating buying some stocks of E-FIN.com which. The firm's most recent annualized dividend is $2.20 per share and this is expected to grow at 4% perpetually. Investors in similar firms in the industry require 12% return. Using the Gordon growth model, calculate its current price. (6 pt.) 4b. The current price of ABC stock is S50.00. Dividends are expected to grow at 6% indefinitely and the most recent dividend was $2.20. What is the required rate of return on ABC stock? (4 pt.)Explanation / Answer
Answer to Q-3:
As the interest payment is done in half yearly intervals, maturity period will be taken as 40 times(20 years*2 frequency of interest). N=frequency(Maturiy period)=40
Value of Bond(Face Value)=$1000 and Coupon rate I=8% Required return(for the purpose of annuity)=13%/2=6.5%
--> Interest for all intervals i,e,40 times will be taken as annuity @6.5%,40 timesAs interest will be received for every half year for the coming 20 years and will be discounted at market rate return to bring the value to present value. As future $1 won`t be equal to present $1.
Value of Bond= Interest*(PVIFAmarket rate of return and maturity period)+Face value of bond*annuity value end of maturity period.
Interest=1000*0.08*1/2=$40(Interest is paid half yearly)
=40*(pvifa@6.5%,40periods)+(1000*PVIA(6.5%,40)
=565.821+80.54
=646.36
Answer to Q-4A:
Current Dividend Do=$2.20
Growth g=4%
Require Return Ke=12%
Price of the stock is P=Do(1+g)/Ke-g
=2.2(1+.04)/(0.12-0.04)
=$28.6
Answer to Q-4b:
Current price of stock P=$50
Growth rate g=6%
Current Dividend Do=$2.2
Required rate of return Ke=(Do(1+g)/P)+g
=(2.2(1+0.06)/50)+0.06
=0.10664
Required rate of return = 10.664%
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