Question

Cassey Computer Ltd. Has an outstanding issue of bond with a par value of $1,000, paying 8 percent coupon rate semi annually. And, the company just paid a dividend of $2.70 per share. The dividends are expected to grow at 5.0 percent for next 2 years. i.e. year 1 and 2, and after year 2, dividends are estimated to grow at 4 percent thereafter indefinitely. Based on market information, government bond’s yield for 10-year maturity is 5 percent, market expected return is 15 percent, and beta of Cassey’s stock is 1.5. Assume no market friction and taxes. Required: (a) The bond of Cassey Computer Ltd. Was issued 25 years ago and has 5 years to maturity. What is the value of the bond assuming 10 percent rate of current interest rate?
(b) If interest rate is expected to decrease, what characteristics and types of bonds would have better performance?

(c) Assume that the forecasted dividends and the required return are the same one year from now, as those forecasted today. What is the expected intrinsic value of the stock one year from now, just after the dividend has been paid in year one?

Answer 1

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