Question

Answer the following questions. Table 6-4 or Table 6-5. (Use appropriate factor(s) from the tables provided. Round the PV factors to 4 decimals.)  

Required:

1. Spencer Co.'s common stock is expected to have a dividend of $6 per share for each of the next 14 years, and it is estimated that the market value per share will be $111 at the end of 14 years. If an investor requires a return on investment of 8%, what is the maximum price the investor would be willing to pay for a share of Spencer Co. common stock today?
2. Mario bought a bond with a face amount of $1,000, a stated interest rate of 10%, and a maturity date 19 years in the future for $975. The bond pays interest on an annual basis. Three years have gone by and the market interest rate is now 14%. What is the market value of the bond today?
3. Alexis purchased a U.S. Series EE savings bond for $200, and ten years later received $518.81 when the bond was redeemed. What average annual return on investment did Alexis earn over the ten years?

Answer 1

Question

a) The maximum price the investor would be willing to pay for a share of Spencer Company's common stock today:-

= 6 * Cumulative Present Value Factor for 14 Years @ 8 % + 111 * Present Value Factor for ^14TH Year @ 8 %

= 4 * 8.2442 + 111 * 0.3405

= 32.9768 + 37.7995

= 70.7723 .i.e., $ 70.77 (approx)

Conclusion:- The maximum price the investor would be willing to pay for a share of Spencer Company's common stock today = $ 70.77 (approx)

Question b)

The market value of the bond today :-

Maturity period for bond now = 19 - 3 = 16 Years.

Market Value of the bond = 1000 * 10 % * Cumulative Present Value Factor for 16 Years @ 14% + 1000 * Present Value Factor for 16^TH Year @ 14 %

= 100 * 6.2651 + 1000 * 0.1229

= 626.51 + 122.9

= $ 749.41

Conclusion:- Market Value of the bond = $ 749.41 (approx)

Question c)

The present value factor = $200/ $518.81 = Initial Investment/ Maturity Value = 0.3855

In Table 6-4 on the 10 th period row 0.3855 is there on 10% column. Therefore, Average annual return on investment = 10%