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**MGT 326 Spring 2015 Test 2 Problem Solutions**

4. A $10,000 face value Diamond Jim’s Corporation bond matures 1 October It has a % coupon rate and pays coupons semiannually. Its YTM as of 14 April 2015 was %. What is this bond’s retail price as of 14 April 2015? SDT = CPN = 5.785 RDT = YLD = 5.42 PRI = %; VB = 100 x = %; = $10,142.78 7. At the beginning of the year a $1,000 face value bond paying a coupon rate of % APR with semiannual payments and 16.5 years maturity was selling at par (excluding fees and transaction costs). At the end of the year the bond's YTM was %. What is the bond’s total yield for the year? Bond Total Yield = EARCoupon + Capital Gains Yield EARCPN = NOM=7.82, C/Y=2; EFF = % VB,0 = $1,000 VB,1: T=15.5, m=2; n = 31; PMT = $1,000(0.0782/2) = $39.10 P/Y=2, N=31, I/Y=8.24, PMT=39.1, FV=1000; CPT, PV: VB,1 = $ Cap Gain Yield = ($ $1,000)/$1,000 = % Total Yield = % % = % 9. What is the fair market value of a $1,000 face value bond that pays annual interest payments of $70 and will mature in five years if the current market interest rates for all bonds of the same maturity and bond rating is %? Quick Way: Find rCPN and compare to rd; rCPN = $70/$1,000 = %; rd = rCPN VB = $1,000; The bond is selling at par. Longer Way: P/Y=1, N=5, I/Y=7, PMT=70, FV=1000, CPT PV; PV = VB = $1,000 10. A $1000 face value bond with a maturity of 10 years and a % coupon rate paying quarterly coupon payments is currently selling for $ (minus fees and transaction costs). What is the yield to maturity of this bond? T=10, m=4; n = 40; PMT = $1,000(0.0536/4) = $13.4 P/Y=4, N=40, PV= , PMT=13.4, FV=1000; CPT, I/Y; YTM = % 13. The stock of Gigantic Jim’s Large & Tall Men’s Clothiers Inc. is currently selling for $50 per share. The firm pays quarterly dividends and plans to pay a dividend of $0.60 at the end of this quarter (i.e. at t=1). The firm's dividends are expected to grow at a rate of 18% per year for the next year (i.e. until t=4). After this time, the dividends are expected to grow at a constant rate of 8% per year for the foreseeable future. The stock's required rate of return is 12%. Is this stock undervalued or overvalued and by how much? 1) Find D2, D3 & D4: D1 = $0.60 D2 = $0.60(1+0.18/4) = $6270; D3 = $0.60(1+0.18/4)2 = $0.6552; D4 = $0.60(1+0.18/4)3 = $0.6847 2) Find PV at t=0 of D1, D2, D3 & D4 and sum them Uneven Cash flow approach: CF, 2nd CLR WORK 0, ENTER ↓, 0.60, ENTER ↓, ↓,0.627, ENTER ↓, ↓, , ENTER ↓, ↓, , ENTER NPV, 3, ENTER (I/Y= rs/m = 12%/4 = 3%) ↓, CPT: NPV = $2.3815 3) Find Horizon Value: D4(1 + gN /m) / (rs/m – gN/m) = $0.6847( /4) / (0.12/4 – 0.08/4) = $ 4) Find PV at t=0 of Horizon Value: P/Y=4, N=4, I/Y=12, FV= ; CPT,PV = $ 5) P0 = $ $ = $64.43; $50 - $ = -$14.43; The stock is undervalued by $14.43 VB,0 1 VB,1 Beginning of the Year End of the Year 7 t = ? (infinity) 4 5 6 1 2 3 rs = 12.0% D2 D3 D4 Supernormal Growth (gSN=18%, t=0 thru t=4) D5 D6 Dinfinity D7 Normal Growth (gN= 8%, t=4 & onward) D1 = $0.60 Horizon Value (VH)

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**MGT 326 Spring 2015 Test 2 Problem Solutions**

14. Reference the stock described in Problem 13 above; what is the expected value of this stock one year from now? Three answers are acceptable: c) VH from Prob. 13 = $69.84 d) P/Y=4, N=4, I/Y=18, PV=64.43, CPT FV, P4= $76.83 e) P/Y=4, N=4, I/Y=18, PV=50, CPT FV, P4= $59.63

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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved CHAPTER 5 How to Value Bonds and Stocks.

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved CHAPTER 5 How to Value Bonds and Stocks.

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