Page |5 3, A twenty-year bond with a 8% coupon rate and a face value of S1000 ma

ID: 2787390 • Letter: P

Question

Page |5 3, A twenty-year bond with a 8% coupon rate and a face value of S1000 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

Price of the bond can be calculated using below formula

If,

Face value (F)= 1000

Interest rate [r]= 0.08

Years to maturity (n)= 20

YTM= 0.1

Annual coupon C= 80

Then the bond price will be,

Price of the bond = C/2[1- (1+ YTM/2)^-2*n/ YTM/2] + F/ (1+ YTM/2)^2*n

= 80/2[1- (1+ 0.1/2)^-2*20/ 0.1/2] + 1000/ 1+ 0.1/2)^2*20

= 40 [1-(1+ 0.05)^-40/ 0.05]+ 1000/ (1+ 0.05)^40

= 40 [1-(1.05)^-40/ 0.05]+ 1000/ (1.05)^40

= 40 [1- 0.142045682300278/ 0.05]+ 1000/ 7.03998871212465

= 40 [0.857954317699722/ 0.05]+ 142.045682300278

= 40 [17.1590863539944]+ 142.045682300278

= 686.363454159778+142.045682300278

= 828.41

Price of the bond is 828.41

Gordon Growth model or dividend discount model

Dividend discounting method is used to find the share present value by discounting the predicted dividend

Formula is,

Value of share = *Dividend per share/ (Discount rate -Dividend growth rate)

Let's put all the values in the formula

= 2.288/ 0.12 -0.04

= 2.288/ 0.08

= 28.6

So the price of the stock is $28.6

*Next year dividend = 2.20 * (1+0.04) = 2.288

Stock price = Next year dividend/( required rate – dividend growth rate0

50 = 2.20 ( 1 + 0.06)/(X – 0.06)

50 = 2.332/(X – 0.06)

X – 0.06 = 2.332/50

X = 0.04664+ 0.06

X = .10664 or 10.66%