Spencer Co.'s common stock is expected to have a dividend of $6 per share for each of the next eleven years, and it is estimated that the market value per share will be $121 at the end of eleven years. If an investor requires a return on investment of 12%, what is the maximum price the investor would be willing to pay for a share of Spencer Co. common stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
b. Mario bought a bond with a face amount of $1,000, a stated interest rate of 6%, and a maturity date fifteen years in the future for $988. The bond pays interest on an annual basis. Three years have gone by and the market interest rate is now 14%. What is the market value of the bond today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
c. Alexis purchased a U.S. Series EE savings bond for $400, and eight years later received $740.33 when the bond was redeemed. What average annual return on investment did Alexis earn over the eight years?
Question 1
Solution: Maximum price of a share of Spencer Co's common stock today = present value of all future benefits
= Present value of future dividends and market share price
= $6{1-(1+0.12)-11} / 0.12 + $121/(1+0.12)11
= $35.626 + $34.785
= $70.41
Question (b)
Solution: Market value of bond today = present value of all remaining future coupons + PV of redemption value
= $60{1-(1+0.14)-12} /0.14 + $1,000/(1.14)12
= $339.618 + 207.559
= $547.18
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