Question

1) You buy a 7 percent coupon, 10-year maturity bond, which was issued in 2015. The yield to maturity is 6 percent.

a) Is this a discount or a premium bond? Explain your answer! (4 points)
b) What is the price of the bond today (in 2017)? (4 points)
c) Tell (without any calculation) the price at which the bond would trade if today the

yield to maturity would be exactly 7%. Support your answer.

2)

Seminar Company will pay a dividend of $3,20 per share, which is expected to grow at a 5 percent rate for the indefinite future. The discount rate is 9 percent.

a) What is the stock selling for today? (price of the share today) (4p)

b) What is the price of the share next year? (4p)
c) What is the expected rate of return of the share?

3)Fitch Industries is in the process of choosing the better of two equal-risk, mutually exclusive capital expenditure projects, M and N. The relevant cash flows for each project are shown in the following table. The firm’s cost of capital is 14%.

a. Calculate each project’s payback period. (4p)
b. Calculate the net present value (NPV) for each project. (6p)

c. Summarize the preferences dictated by each measure you calculated and indicate which project you would recommend. Explain why.

Answer 1

1. (a) Since the prevailing interest rate in the market (YTM) is less than the coupon rate of the bond, hence the bond must be trading at a premium.

(b)

Par Value	100
Coupon rate	7%
Time to maturity	8
YTM	6%
Bond price	106.28

(c) If YTM = Coupon rate = 7%, the bond would trade at par. Hence, the price of the bond will be equal to its par value ($100)

2. (a) DIVIDEND GROWTH MODEL

Price of 1 share (Po) = 3.20/(9%-5%) = $80

(b) Ex dividend share price in year 2 = P1*(1+g)

Cumulative dividend share price in year 2 = P1*(1+r)

Expected Dividend ($)	3.2
Discount rate (r)	9%
Dividend growth rate (g)	5%
Price per share (P1) ($)	80
Share price next year
Ex dividend price ($)	84
Cumulative dividend price ($)	87.2

(c) Expected rate of return from share in Year 1 = Expected dividend payment in year 1 / Price per share in year 0 + g = 3.2/80 + 5% = 9%

3. (a) Project M : $28,500 / $10,000 = 2.85 years

Project N : 2 + [($27,000 - $21,000) / $9,000] = 2.67 years

(b)

	M	N
Initial investment	-28500	-27000
Year	M	N
1	10000	11000
2	10000	10000
3	10000	9000
4	10000	8000
NPV	637.12	1155.18

(c) Through both measures, Project N comes out to be superior.