Question

a)Which is the intrinsic value of a bond, issued in the past with 3 years to maturity, € 1000 face value and coupon rate 7%, if the coupon payments are annual and today’s bond issues yield 9%?

B)Firm ABC plans to issue a new preferred stock in order to finance an investment project. The stock will be sold at its par value which is €100. The annual dividend of the preferred stock will be 15% of its par value. The firm estimates that the flotation costs will be 2.5% of its par value. Calculate the cost of the preferred stock.

c)You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both €1.25 in dividends and €32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return (two decimals no rounding).

Answer 1

a) Intrinsic Value of the bond is the sum of Presnt value of the cash flows ie principal & the coupons

Intrinsic Value = Coupons * PVIFA (r,n) + Principal * PVIF ( r,n )

PVIFA = { 1 - [ (1+r)^-n ] / r } = { 1 - [ (1+0.09)^-3 ] / 0.09} = 2.5313

PVIF = 1 / (1+r)^n = 1 / 1.09^3 = 0.7722

Intrinsic Value = 7 * PVIFA ( 9 % , 3 ) + 1000 * PVIF ( 9% , 3)

= 7 * 2.5313 + 1000 * 0.7722

= 17.72 + 772.20

= $789.92

b)

Cost of Preferred equity = Fixed Dividend / Net Proceeds

Net Proceeds = Sale Price - Floatation costs = 100 - 2.5%*100 = 97.50

Dividend = 15% *100 = 15

Cost of Preferred equity = 15 / 97.50 *100 = 15.38%

c) The maximum one can give for the stock is the present value of the cash flows recieved from stock in ine year

Present value = Dividend in year 1 / ( 1+r) + Stock price after 1 year / ( 1+r)

= 1.25 /1.10 + 32/1.10

= 1.14 + 29.09

= $30.23