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MGT 326 Spring 2015 Test 2 Problem Solutions 1 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 = RDT = YLD = 5.42 PRI = %; V B = 100 x = %; = $10, 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 = EAR Coupon + Capital Gains Yield EAR CPN = NOM=7.82, C/Y=2; EFF = % V B,0 = $1,000 V B,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: V B,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 r CPN and compare to r d ; r CPN = $70/$1,000 = %; r d = r CPN V B = $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 = V B = $1, 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 D 2, D 3 & D 4 : D 1 = $0.60 D 2 = $0.60(1+0.18/4) = $6270; D 3 = $0.60(1+0.18/4) 2 = $0.6552; D 4 = $0.60(1+0.18/4) 3 = $ ) Find PV at t=0 of D 1, D 2, D 3 & D 4 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= r s /m = 12%/4 = 3%) ↓, CPT: NPV = $ ) Find Horizon Value: D 4 (1 + g N /m) / (r s /m – g N /m) = $0.6847( /4) / (0.12/4 – 0.08/4) = $ ) Find PV at t=0 of Horizon Value: P/Y=4, N=4, I/Y=12, FV= ; CPT,PV = $ ) P 0 = $ $ = $64.43; $50 - $64.43 = -$14.43; The stock is undervalued by $14.43 V B,0 0 1 V B,1 Beginning of the Year End of the Year 7t = ? (infinity) r s = 12.0% D2D2 D3D3 D4D4 Supernormal Growth (g SN =18%, t=0 thru t=4) D5D5 D6D6 D infinity D7D7 Normal Growth (g N = 8%, t=4 & onward) D 1 = $0.60 Horizon Value (V H )

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MGT 326 Spring 2015 Test 2 Problem Solutions 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) V H from Prob. 13 = $69.84 d) P/Y=4, N=4, I/Y=18, PV=64.43, CPT FV, P 4 = $76.83 e) P/Y=4, N=4, I/Y=18, PV=50, CPT FV, P 4 = $59.63

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