Valuation practice problems

Prepared by Pamela Peterson Drake

Asset valuation
1. Consider an investment that promises cash flows of $4,000 at the end of two years and
$5,000 at the end of three years. If your required rate of return on this investment is 10%,
what is the value of this investment?
2. Consider an investment that promises cash flows of $3,000 at the end of the first year and
$2,000 at the end of the second year. If you pay $4,500 for this investment, what is your
return on your investment?
3. What is the value at the end of 2005 of the following set of cash flows if the discount rate is
6%?

End of year Cash flow

2006 $10,000
2007 $0
2008 $4,000
2009 $5,000

Stock valuation
1. If the required rate of return on a common stock were to increase, what would you expect to
happen to the price of a share of the stock (assuming no other changes)?
2. Calculate the price of a share of stock for each company, given the information regarding
dividends, the growth rate of dividends, and the required rate of return:

Current dividend Expected growth Required rate

Company
per share rate of dividends of return
Company 1 $2.00 5% 10%
Company 2 $3.00 3% 7%
Company 3 $5.00 2% 6%
Company 4 $2.25 0% 8%
Company 5 $2.00 -5% 6%

3. Interview, Inc. paid dividends of $0.055 per share in 2004. In 2008, Interview paid dividends
of $0.09 per share. What was the average annual growth rate of Interview's dividends from
2004 to 2008?

Bond valuation

1. Consider a bond that has ten years remaining to maturity, a 10% coupon (interest paid semi-
annually), and a maturity value of $1,000.
a. If the yield on the bond is 10%, what is the value of the bond today?
b. If the yield on the bond is 8%, what is the value of the bond today?
c. If the yield on the bond is 12%, what is the value of the bond today?
2. The XYZ bond has a maturity value of $1,000 and a 10% coupon, with interest paid semi-
annually.
a. If there are five years remaining to maturity and the bonds are priced to yield 8%,
what is the bond's value today?
b. If there are five years remaining to maturity and the bonds are priced to yield 10%,
what is the bond's value today?
c. If there are five years remaining to maturity and the bonds are priced to yield 12%,
what is the bond's value today?
3. What is the value of a zero-coupon bond that has five years remaining to maturity and has a
yield-to-maturity of:
a. 6%?
b. 8%?
c. 10%?