Assignment
1. Ron Rhodes calls his broker to inquire about purchasing a bond of Golden Years Recreation Corporation. His broker quotes a price of $1,170. Ron is concerned that the bond might be over priced based on the facts involved. The $1,000 par value bond pays 13 percent interest, and it has 18 years remaining until maturity. The current yield to maturity on similar bonds is 11 percent.
Do you think the bond is overpriced? Do the necessary calculations.
2. Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 25 year life when issued and the annual interest payment was then 12 percent. This return was in line with the required by bondholders at that point as described below:
Real rate of return...........................3%
Inflation premium............................5 (3)
Risk premium.................................4
Total return.........................12% (10%)
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until maturity. Compute the new price of the bond.
3. Media Bias, Inc. issued bonds 10 years ago at $1,000 per bond. These bonds had a 35-year life when issued and the annual interest payment was then 10 percent. This return was in line with the required returns by bondholder at that point in time as described below:
Real rate of return...........................2%
Inflation premium............................4
Risk premium.................................4 (2)
Total return..........................10% (8%)
Assume that 10 years later, due to good publicity, the risk premium is now 2 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 25 years remaining until maturity. Compute the new price of the bond.
4. Bonds issued by the Coleman Manufacturing Company have a par value of $1,000, which, of course, is also the amount of principal to be paid at maturity. The bonds are currently selling for $850. They have 10 years remaining to maturity. The annual interest payment is 8 percent ($80).
Compute the approximate yield to maturity, using formula 10-2 on page 294.
5. The preferred stock of Denver Savings and Loan pays an annual dividend of $5.60. It has a required rate of return of 8 percent. Compute the price of the preferred stock.
6. Bedford Mattress Company issued preferred stock many years ago. It carries a fixed dividend of $8 per share. With the passage of time, yields have gone down from the original 8 percent to 6 percent (yield is the same as required rate of return).
a.) What was the original issue price?
b.) What is the current value of this preferred stock?
7. Grant Hillside Homes, Inc., has preferred stock outstanding that pays an annual dividend of $9.80. Its price was $110. What is the required rate of return (yield) on the preferred stock?
8. Laser Optics will pay a common stock dividend of $1.60 at the end of the year (D1). The required rate of return on common stock (Ke) is 13 percent. The firm has a constant growth rate (g) of 7 percent. Compute the current price of the stock (P0).
9. Sterling Corp. paid a dividend of $.80 last year. Over the next 12 months, the dividend is expected to grow at a rate of 10 percent, which is the constant growth rate for the firm (g). The new dividend after 12 months will represent D1. The required rate of return (Ke) is 14 percent. Compute the price of the stock (P0).