1. You own some bonds issued by Another Failing Airline Inc. (AFA). When AFA issued the bonds it was in good financial health and was able to get a coupon rate of 6.6%. The bonds pay coupons annually, and have exactly 10 years remaining until maturity. Each bond has a face value of $1000.
Due to the recent increase in operating costs, most notably fuel prices, AFA is no longer able to pay the coupon payments on its bonds. At a creditors meeting, bond holders agreed to forgive the next 3 interest payments (starting with the payment due one year from today). This means that the next interest payment on the bonds will be made 4 years from today. After that, interest payments will be made annually until maturity. Given the risk of AFA and its recent credit downgrade to CC, the required return on these bonds is now 17.3%.
What is the fair price of one AFA bond
2. Which of the following statements is FALSE?
A. If the forecasted growth rate in Earnings per Share (EPS) decreases, this leads to a decrease in share price valuation.
B. The growth rate in EPS is a function of the Dividend Payout Ratio (DPR), amongst other things.
C. Required return on equity is usually less than that for debt for any given firm.
D. The dividend growth model is used for share valuation purposes.