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Complete Solutions For Chapter 04

|| The Valuation Of Long-Term Securities ||

We are providing solutions of Question 01 – 14 here, Solutions to Self-Correction Problems are given at the end of chapter 04,
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1. End of Discount
Year Payment Factor (14%) Present Value

1 $ 100 .877 $ 87.70

2 100 .769 76.90

3 1,100 .675 742.50

Price per bond $ 907.10

2. End of Six- Discount

month Period Payment Factor (7%) Present Value

1 $ 50 .935 $ 46.75

2 50 .873 43.65

3 50 .816 40.80

4 50 .763 38.15

5 50 .713 35.65

6 1,050 .666 699.30

Price per bond $ 904.30

3. Current price: P0 = Dp/kp = (.08)($100)/(.10) = $80.00

Later price: P0 = Dp/kp = ($8)/(.12) = $66.67

The price drops by $13.33 (i.e., $80.00 - $66.67).

 4. $1 dividend + ($23 - $20) capital gain
Rate of return =
$20 original price

= $4/$20 = 20%

5- Phases 1 & 2: Present Value of Dividends to Be Received Over First

6 Years

Present Value Calculation

End of Present Value
Year (Dividend x PVIF18%,t) of Dividend

P
h 1 $2.00(1.15)1 = $2.30 x .847 = $ 1.95 a
s 2 2.00(1.15)2 = 2.65 x .718 = 1.90
e
3 2.00(1.15)3 = 3.04 x .609 = 1.85
1

Phase 3: Present Value of Constant Growth Component

Dividend at the end of year 7 = $4.05(1.05) = $4.25

Value of stock at D7 $4.25

= =
the end of year 6 = $32.69
(ke - g) (.18 - .05)
 Present value of $32.69
at end of year 6 = ($32.69)(PVIF18%,6)

= ($32.69)(.370) = $12.10

Present Value of Stock

V = $10.53 + $12.10 = $22.63

6. a) P0 = D1/(ke - g): ($1.50)/(.13 - .09) = $37.50

b) P0 = D1/(ke - g): ($1.50)/(.16 - .11) = $30.00

c) P0 = D1/(ke - g): ($1.50)/(.14 - .10) = $37.50

Either the present strategy (a) or strategy (c).Both result in the same market price

per share.

7. a) kp = Dp/P0: $8/$100 = 8 percent

b) Solving for YTC by computer for the following equation

$100 = $8/(1 +YTC)1 + $8/(1 + YTC)2 + $8/(1 + YTC)3

+ $8/(1 + YTC)4 + $118/(1 + YTC)5

We get YTC = 9.64 percent. (If the students work with present-value tables, they

should still be able to determine an approximation of the yield to call by making

use of a trial-and-error procedure.)

8. V = Dp/kp = [(.09)($100)]/(.12) = $9/(.12) = $75

9. V = (I/2)(PVIFA7%,30) + $1,000(PVIF7%,30)

= $45(12.409) + $1,000(.131)

= $558.41 + $131 = $689.41

10. a) P0 = D1/(ke - g) = [D0(1 + g)]/(ke - g)

$21 = [$1.40(1 + g)]/(.12 - g)

$21(.12 - g) = $1.40(1 + g)

$2.52 - $21(g) = $1.40 + $1.40(g)

$1.12 = $22.40(g)

g = $1.12/$22.40 = .05 or 5 percent

b) expected dividend yield = D1/P0 = D0(1 + g)/P0

= $1.40(1 + .05)/$21 = $1.47/$21 = .07

c) expected capital gains yield = g = .05

11. a) P0 = (I/2)/(semiannual yield)

$1,120 = ($45)/(semiannual yield)

semiannual yield = $45/$1,120 = .0402

b) (semiannual yield) x (2) = (nominal annual) yield

(.0402) x (2) = .0804

c) (1 + semiannual yield)2 - 1 = (effective annual) yield

(1 + .0402)2 - 1 = .0820
12. Trying a 4 percent semiannual YTM as a starting point for a trial- and-error approach,

we get

P0 = $45(PVIFA4%,20) + $1,000(PVIF4%,20)

= $45(13.590) + $1,000(.456)

= $611.55 + $456 = $1,067.55

Since $1,067.55 is less than $1,120, we need to try a lower

discount rate, say 3 percent

P0 = $45(PVIFA3%,20) + $1,000(PVIF3%,20)

= $45(14.877) + $1,000(.554)

= $669.47 + $554 = $1,223.47

X $103.47 (.01) x ($103.47)

= Therefore, X = = .0066
.01 $155.92 $155.92

and semiannual YTM = .03 + X = .03 + .0066 = .0366, or 3.66

percent.(The use of a computer provides a precise semiannual YTM
figure of 3.64 percent.)
 b) (semiannual YTM) x (2) = (nominal annual) YTM

(.0366) x (2) = .0732

c) (1 + semiannual YTM)2 - 1 = (effective annual) YTM (1 + .0366)2 - 1 = .0754

13. a) Old Chicago's 15-year bonds should show a greater price change than Red Frog's

bonds. With everything the same except for maturity, the longer the maturity,

the greater the price fluctuation associated with a given change in market

required return. The closer in time that you are to the relatively large

maturity value being realized, the less important are interest payments in

determining the market price, and the less important is a change in market

required return on the market price of the security.

b) (Red Frog):

P0 = $45(PVIFA4%,10) + $1,000(PVIF4%,10)

= $45(8.111) + $1,000(.676)

= $365 + $676 = $1,041

(Old Chicago):

P0 = $45(PVIFA4%,30) + $1,000(PVIF4%,30)

= $45(17.292) + $1,000 (.308)

= $778.14 + $308 = $1,086.14

 Old Chicago's price per bond changes by ($1.086.14 - $1,000) = $86.14, while Red
Frog's price per bond changes by less than half that amount, or ($1,041 - $1,000)
= $41.

14. D0(1 + g)/(ke - g) = V

a) $2(1 + .10)/(.16 - .10) = $2.20/.06 = $36.67

b) $2(1 + .09)/(.16 - .09) = $2.18/.07 = $31.14

c) $2(1 + .11)/(.16 - .11) = $2.22/.05 = $44.40

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