Question

XYZ has ine share of stock and one bond. The total value of the teosecurities is $1,100. The bond has a YTM of 12.60 percent,a coupon rate of 9.60 percent, and a face value of $1000; pays semi-annual coupons with the next one expected in 6 months; and matures in 3 years. The stock pays annual dividends that are expected to grow by 4.82 percent per year forever. The next dividend is expected to be $13.40 and paid in one year. What is the expected return for the stock?

Answer 1

We have to find the price of the bond using PV function in EXCEL

Please note that the payments are semi-annual

=PV(rate,nper,pmt,fv,type)

rate=12.6%/2=6.3%

nper=3 years*2=6

pmt=semi-annual coupon=(coupon rate*face value)/2=(9.6%*1000)/2=96/2=48

fv=face value=1000

=PV(6.3%,6,48,1000,0)=$926.93

==> price of the bond=$926.93

Total value of one sahre+one bond=1100

One sahre value=1100-926.93=173.07

Expected return on Stock=(Dividend next year/Share value)+growth rate=(13.4/173.07)+4.82%=7.74%+4.82%=12.56%