Question

1. O'Brien Ltd.'s outstanding bonds have a $1,000 par value, and they mature in 25 years. Their yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $875. What is the bond's coupon interest rate?

2. Stocks X just paid a dividend of $1 and a has a dividend growth rate of 10 percent. If the required rate of return is 20 percent, what is the value of the stock in one year?

3. The price of Natter Corporation’s stock is $50. The stock’s dividend is expected to grow at a constant rate of 8 percent, and it just paid a dividend of $2. What is the stock's expected rate of return?

4. Assume you think the expected rate of return is too low. What should you do?

Group of answer choices

Sell the stock if you own it.

Not enough information to say.

Do nothing

Buy the stock.

5. Assume a firm's WACC is 10 percent. Calculate the NPV for the following project if its cost was $8,000 and the annual expenditures and costs were:

Year 1	Year 2	Year 3	Year 4	Year 5
$3,000	$3,000	$3,000	$3,000	-$2,000

6. Calculate the IRR for the following project if its cost was $8,000 and the annual expenditures and costs were:

Year 1	Year 2	Year 3	Year 4	Year 5
$3,000	$3,000	$3,000	$3,000	-$2,000

Answer 1

(1)

Yield – to – Maturity of the Bond (YTM)

YTM = {C+(F - P)/n} / {(F + P)/2}

9.25% = {C + (1000 – 875)/50} / {1000 + 875/2}

0.0925 = (C+2.5) / 937.5

C = $ 84.22

Since the interest pays semiannually therefore the Coupon interest would be 84.22*2/1000*100 = 16.84%

(2)

Present value per share of common stock = D1 / (Re – g)

Where D1 = Expected dividend for next year = $ 1*1.1 = $ 1.1

Re = Cost of equity = required rate of return = 20%

g = Constant growth rate for dividend, in perpetuity = 10%

Present value per share of common stock = 1.1/(0.20-0.10)

= 1.1/0.10

= $ 11

Therefore the value of stock in one year is $ 11

(3)

Expected rate of return = (Expected Dividend for next year / Current price*100) + growth rate

Expected dividend for next year = $ 2*1.08 = $ 2.16

Expected rate of return = $2.16/$50*100 + 8

= 4.32+8

= 12.32%

(4)

If the CAPM > Expected return, This is due to the stock being overvalued i.e. stock gives less return than what it should give, therefore should sell the stock.