Question

Question 1. The DDM model assumes that the value of a share of stock equals the present value of its expected future cash receipts. The elements of the computation are: Dividend one year hence: D(1) = €3, Stock price one year hence: P(1) = €24 and Annual risk adjusted discount rate:1 k = 12.5%.

Question 2. The Blue Dog Company has common stock outstanding that has a current price of $20 per share and a $0.5 dividend. Blue Dog’s dividends are expected to grow at a rate of 3% per year, forever. The expected risk-free rate of interest is 2.5%, whereas the expected market premium is 5%. The beta on Blue Dog’s stock is 1.2 . a) What is the cost of equity for Blue Dog using the dividend valuation model?, b) What is the cost of equity for Blue Dog using the capital asset pricing model?

Question 3. Problem: Suppose you have the following about a bond: Price = $1,494.96 Par Value = $1,000.00, Coupon Rate =10%, N=14. Please find the YTM.

Question 4. Find the price of a 8% coupon bond (semi-annual payments) with a par value of $1,000 and a 15-year maturity if the market rate on similar bonds is 10%.

Answer 1

Question 1. The DDM model assumes that the value of a share of stock equals the present value of its expected future cash receipts. The elements of the computation are: Dividend one year hence: D(1) = €3, Stock price one year hence: P(1) = €24 and Annual risk adjusted discount rate:1 k = 12.5%.

FALSE; elements of computation are: D1, Stock price today, P(0) = D1/k = 3 / 12.5% = 24 and k = 12.5%

Question 2. The Blue Dog Company has common stock outstanding that has a current price of $20 per share and a $0.5 dividend. Blue Dog’s dividends are expected to grow at a rate of 3% per year, forever. The expected risk-free rate of interest is 2.5%, whereas the expected market premium is 5%. The beta on Blue Dog’s stock is 1.2 . a) What is the cost of equity for Blue Dog using the dividend valuation model?, b) What is the cost of equity for Blue Dog using the capital asset pricing model?

a) Cost of equity, Ke = D0 x (1 + g) / P0 + g = 0.5 x (1 + 3%) / 20 + 3% = 5.575%

b) Cost of equity using CAPM = Ke = risk free rate + Beta x expected market premium = 2.5% + 1.2 x 5% = 8.5%

Question 3. Problem: Suppose you have the following about a bond: Price = $1,494.96 Par Value = $1,000.00, Coupon Rate =10%, N=14. Please find the YTM.

YTM = RATE (Period, PMT, PV, FV) = RATE (14, 10% x 1000, -1494.96, 1000) = 5.00%

Question 4. Find the price of a 8% coupon bond (semi-annual payments) with a par value of $1,000 and a 15-year maturity if the market rate on similar bonds is 10%.

Semi annual coupon payment. Hence one period is 6 months

Price = - PV (Rate, Period, PMT, FV) = - PV (10% / 2, 2 x 15, 8%/2 x 1000, 1000) = $  846.28