Homework: STOCK AND BOND VALUATION
Before starting on this homework, make sure to thoroughly review the required background materials. This homework will require you to use the various discounted cash flow methods and dividend models to make computations. In addition to knowing the computational steps involved in stock and bond valuation, make sure you also understand the basic concepts.
Case Homework
I. Suppose you buy a bond that will pay $1000 in ten years along with an annual coupon payment of $50 and the interest rate is 4%. Answer the following questions:
1) What is the value of this bond?
2) Now suppose the bond has no coupon payments (it is a "zero coupon" bond) but still pays $1000 in ten years. What is the value of this bond?
3) What would happen to the value of the bond if the inflation rate unexpectedly goes up? What the bond value increase or decrease?
4) Now suppose the bond still pays an annual coupon of $50 but the interest rate drops to 2%. What is the new value of this bond?
II. The XYZ Corporation pays a dividend of $1 for each share and its required rate of return is 8%. Answer the following questions:
1) Assuming zero growth in dividends, what is the value of each share?
2) Now assume a 4% annual growth rate in the dividend paid. What is the value of each share?
3) Assume the growth rate is still 4%, but the required rate of return drops to 6%. What is the new value of each share?
III. Acme Medical Corp. is expecting the cash flows from 2018-2022 in the table below. After 2022 it is expecting growth in cash flow at an annual rate of 3%. The firm has determined that its weighted average cost of capital (discount rate) is 7%. Using the table below calculate the following:
1) What is the present value of Acme's future cash flows using the discounted cash flow model?
2) If the firm has 200,000 common shares outstanding, zero preferred shares, and debt with a market value of $10,000,000 what would be the value of each share?
3) Now suppose the discount rate increases to 10%. How would your answers to a) and b) above change based on the new discount rate?
Year Cash flow
2018 500,000
2019 550,000
2020 620,000
2021 700,000
2022 800,000
Suppose the Alpha Manufacturing Corporation is experiencing extreme financial difficulties and is considering bankruptcy. Its shareholders are currently almost equally divided about whether or not the company should go bankrupt, with one outspoken faction pushing for bankruptcy and the other strongly opposing it. They have $50 million in debt all in the form of bonds, and bondholders are pretty well united in that they want the firm to declare bankruptcy.
1) The CEO announces that he is leaning against bankruptcy. This means one faction of shareholders is happy, but another faction of shareholders is very upset and the bondholders are also unhappy. Can the unhappy faction of shareholders team up with the bondholders to vote out the CEO? Explain your reasoning using references from the background readings.
2) Suppose Alpha ends up declaring bankruptcy. They do not have any cash in the bank but they own $60 million worth of real estate. They only have one type of shareholder-common shareholders. If they sell the real estate, how much of this will bondholders get and how much with shareholders get? Explain your reasoning using references from the background readings.
3) Now suppose that Alpha has two classes of shareholders-common shareholders and preferred shareholders. Preferred shareholders are owed $20 million in dividends that have been unpaid in the last two years. If Alpha goes bankrupt and sells its $60 million worth of real estate, how much will bondholders get, how much will common shareholders get, and how much will preferred shareholders get? Explain your reasoning using references from the background readings.
Format your homework according to the following formatting requirements:
(1) The answer should be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides.
(2) The response also includes a cover page containing the title of the homework, the student's name, the course title, and the date. The cover page is not included in the required page length.
(3) Also include a reference page. The Citations and references should follow APA format. The reference page is not included in the required page length.