Question

QUESTION 3
SHARE AND BOND VALUATION [16 MARKS]
A. Share Valuation
A share has just paid a dividend of K10 and is expected to grow at a rate of 8 percent per year
for the next two years. After that, it is expected to grow at 5 percent per year indefinitely. The
required rate of return on the share is 10 percent. Calculate the value of the share
B. Bond Valuation
Calculate the value of a K1000 par value bond with a maturity of 20 years. The bond has a
stated annual coupon rate of 10%, and the yields of comparable bonds in the market are 8%.
Assume further that the bond pays interest annually.

Answer 1

A. Share Valuation

This requires application of dividend discount model, according to which current value of share is present value of all dividends expected for the share in future.

where V2 is the terminal value or the value when the constant growth in dividends start.

D0 = K10

D1 = 10 * (1 + 8%) = K10.8000

D2 = 10.8 * (1 + 8%) = K11.6640

D3 = 11.664 * (1 + 5%) = K12.2472

V2 = K244.9440

V0 = 9.8182 + 9.6397 + 202.4331

V0 = K221.89 ---> Value of share today

2. Bond Valuation

Price of a bond is mathematically calculated using the mathematical relation:

where P is Price of a bond with periodic coupon C, face value M, periodic YTM i and n periods to maturity

C = 10% * K1000 = 100

i = 8%

n = 20

P = 981.8147 + 214.5482

P = K1,196.36