Valuation and Characteristics of Bonds and Stocks (130 Points)
Complete the following problems. You will likely use a spreadsheet for this assignment but you may choose to type up your answers in a Word document. In either case, be sure to show your work. Support your answers by showing the formulas you use and defining any variables in the formulas.
Problem 10-1: Bond Valuation 1
Calculate the value of a bond that will mature in 17 years and has a SAR 1,000 face value. The annual coupon interest rate is 6 percent, and the investor's required rate of return is 8 percent.
| DATA |
| Years | 17 |
| Face value | 1,000 |
| Interest | 6.0% |
| Required rate of return | 8.0% |
Solution: Problem 10-2: Bond Valuation 2Calculate the value of a bond that will mature in 9 years and has a SAR 1,000 face value. The interest rate is 8 percent and is paid semi-annually, and your required rate of return is 5 percent. What is the value of the bond if interest is paid annually?
| DATA |
| Coupon rate | 8.0% |
| Times interest paid | semi-annual |
| Years to Maturity | 9 |
| Par Value | 1,000 |
| Required rate of return | 5.0% |
Solutions: | B) If the interest is annual = |
|
Problem 10-3: Bond Valuation 3Global Corporation issued a bond with a SAR 1,000 par value that pays SAR 50 in annual interest. The bond matures in 20 years. Your required rate of return is 6 percent.
a. Calculate the value of the bond.
b. How does the value change if your required rate of return (1) increases to 8 percent or (2) decreases to 4 percent?
c. Explain the implications of your answers in part b. as they relate to interest rate risk, premium bonds, and discount bonds.
d. Assume that the bond matures in 10 years instead of 20 years. Re-compute your answers in part b.
e. Explain the implications of your answers in part d. as they relate to interest rate risk, premium bonds, and discount bonds.
| DATA |
| Years | 20 |
| Interest | 5.0% |
| Bond | 1,000 |
| Required rate of return | 6.0% |
Solutions: | B) |
| Required rate of return | 8.0% |
| The value of bond |
| Required rate of return | 4.0% |
| The value of bond |
C)
| D) |
| Years | 10 |
| Required rate of return | 6.0% |
| The value of bond |
| Required rate of return | 8.0% |
| The value of bond |
| Required rate of return | 4.0% |
| The value of bond |
E)
Problem 10-4: Preferred Stock ValuationPreferred stock issued by Saudi, Inc. is selling for SAR 45.00 per share in the market and pays a SAR 4.00 annual dividend.
a. What is the expected rate of return on the stock?
b. If an investor's required rate of return is 8 percent, what is the value of the stock for that investor?
c. Should the investor acquire the stock?
| DATA |
| Market Price | 45.00 |
| Dividend | 4.00 |
Solutions | A) |
| Expected rate of return = |
| B) |
| Required rate of return = | 8.0% |
| Value = |
| C) |
|
Problem 10-5: Common Stock Valuation 1Jeddah Corporation has a 14 percent return on equity and retains 60 percent of its earnings for reinvestment purposes. The company recently paid a dividend of SAR 4.50 and the stock is currently selling for SAR 42.
a. What is the growth rate for Jeddah Corporation?
b. What is the expected return for Jeddah stock?
c. If you require a 15 percent return would you invest in Jeddah stock?
| DATA |
| Return of equity | 14.0% |
| Retention rate | 60.0% |
| Dividend | 4.50 |
| Market price | 42.00 |
Solutions | A) |
| Growth rate |
| B) |
| Next year's dividend |
| Expected return |
| C) |
| Required rate of return | 15.0% |
| Present value |
Problem 10-6: Common Stock Valuation 2Saudi Enterprises is selling for SAR 73.75 per share and paid a dividend of SAR 1.25 last year. The dividend is expected to grow at 6 percent indefinitely. What is the stock's expected rate of return?
| DATA | |
| Market price | 73.75 |
| Most recent annual dividend | 1.25 |
| Growth rate | 6.0% |
Solution | Forthcoming dividend |
| Dividend yield |
| Growth rate | 6.0% |
| Expected rate of return |
Problem 10-7: Cost of Trade CreditCalculate the effective cost of the following trade credit terms when payment is made on the net due date.
| A) |
| 3/12, net 30: |
| Percent | 3% |
| Days | 12 |
| Net | 30 |
| Effective cost = |
| B) |
| 2/12, net 30: |
| Percent | 2% |
| Days | 12 |
| Net | 30 |
| Effective cost = |
| C) |
| 2/12, net 45: |
| Percent | 2% |
| Days | 12 |
| Net | 45 |
| Effective cost = |
| D) |
| 3/15, net 60: |
| Percent | 3% |
| Days | 15 |
| Net | 60 |
| Effective cost = |