Question

Following are the securities and projections for Mogul Corp:

Stock A: REQUIRED RATE OF RETURN   = 5%

Constant-growth-growth rate of 3% D0= $3.00

Stock B: REQUIRED RATE OF RETURN   = 7%

D0= $4.00, growth at 5% per year for 2 years, followed by 4% forever

Stock C: REQUIRED RATE OF RETURN = 9%

D0= $2.00, growth at 25% for next 4 years, followed by 5% forever

Mogul has a 3.5% Treasury bond, semi-annual interest, with 4 years left to maturity and a quoted

price of $962.81.

PRIMARY POST: Question 3

1) Calculate the bond’s current yield and yield to maturity.

2) Calculate the value per share today for stock A.

3) Calculate the value per share 4 years from today for stock B

4) Calculate the value per share today for stock C.

REPLY POST: Question 3

1) Calculate the bond’s capital gain yield.

2) Calculate the value per share one year from today for stock A.

3) Calculate the value per share today for stock B.

4) 3) Do you agree with the stock valuation in part 4 of the primary post? If the stock was selling for $143.01 on January 1, 2018, would you purchase it? Use the correct stock valuation as the basis for your answer.

Answer 1

Since, there are multiple parts to the question, I have answered the all the parts of PRIMARY POST: Question 3.

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Part 1)

The bond's current yield is calculated as below:

Bond's Current Yield = Annual Coupon/Current Bond Price*100 = (1,000*3.5%)/962.81*100 = 3.64%

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The bond's yield to maturity can be calculated with the Rate function/formula of EXCEL/Financial Calculator. The function/formula for Rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Payment (here, Coupon Payment), PV = Present Value (here, Current Bond Price) and FV = Future Value (here, Face Value of Bonds).

Here, Nper = 4*2 = 8, PMT = 1,000*3.5%*1/2 = $17.50, PV = $962.81 and FV = $1,000

Using these values in the above function/formula for Rate, we get,

Yield to Maturity = Rate(8,17.50,-962.81,1000)*2 = 4.53%

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Part 2)

The value per share today for stock A is arrived as follows:

Value Per Share Today for Stock A = D0*(1+Growth Rate)/(Required Rate of Return - Growth Rate)

Substituting values in the above formula, we get,

Value Per Share Today for Stock A = 3*(1+3%)/(5%-3%) = $154.50

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Part 3)

The value per share 4 years from today for stock B is calculated as below:

Value Per Share 4 Years from Today for Stock B = D3/(Required Return - Growth Rate)*[(1+Growth Rate from Year 3 Onwards)^1]

Substituting values in the above formula, we get,

Value Per Share 4 Years from Today for Stock B = 4*(1+5%)^2*(1+4%)/(7% - 4%)*[(1+4)%)^1] = $159.00

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Part 4)

The value per share today for stock C can be calculated with the use of following formula:

Value Per Share Today for Stock C = D1/(1+Required Rate of Return)^1 + D2/(1+Required Rate of Return)^2 + D3/(1+Required Rate of Return)^3 + D4/(1+Required Rate of Return)^4 + D4*(1+Growth Rate from Year 5 Onwards)/(Required Return - Growth Rate from Year 5 Onwards)*1/(1+Required Rate of Return)^4

Here,

D1 = D0*(1+Growth Rate) = 2*(1+25%)

D2 = D0*(1+Growth Rate)^2 = 2*(1+25%)^2

D3 = D0*(1+Growth Rate)^3 = 2*(1+25%)^3

D4 = D0*(1+Growth Rate)^3 = 2*(1+25%)^4

Substituting these values in the above formula, we get,

Value Per Share Today for Stock C = 2*(1+25%)/(1+9%)^1 + 2*(1+25%)^2/(1+9%)^2 + 2*(1+25%)^3/(1+9%)^3 + 2*(1+25%)^4/(1+9%)^4 + 2*(1+25%)^4*(1+5%)/(9% - 5%)*1/(1+9%)^4 = $102.20