Class_3_Solutions

Class_3_Solutions - FM212 Class work solutions Class...

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FM212 Class work solutions Class 3 (Chapters 4.1 and 5) 10. a. $100.00 0.10 $10 r DIV P 1 A = = = b. $83.33 .04 0 0.10 $5 g r DIV P 1 B = - = - = c. × + + + + + + = 6 7 6 6 5 5 4 4 3 3 2 2 1 1 C 1.10 1 0.10 DIV 1.10 DIV 1.10 DIV 1.10 DIV 1.10 DIV 1.10 DIV 1.10 DIV P $104.50 1.10 1 0.10 12.44 1.10 12.44 1.10 10.37 1.10 8.64 1.10 7.20 1.10 6.00 1.10 5.00 P 6 6 5 4 3 2 1 C = × + + + + + + = At a capitalization rate of 10 percent, Stock C is the most valuable. For a capitalization rate of 7 percent, the calculations are similar. The results are: P A = $142.86 P B = $166.67 P C = $156.48 Therefore, Stock B is the most valuable. 11. Purchase price for a 6-year government bond with 5 percent annual coupon: 1,108.34 (1.03) 1,000 (1.03) 0.03 1 0.03 1 50 PV 6 6 = + × - × = Price one year later (yield = 3%): 1,091.59 (1.03) 1,000 (1.03) 0.03 1 0.03 1 50 PV 5 5 = + × - × = Rate of return = [$50 + ($1,091.59 – $1,108.34)]/$1,108.34 = 3.00% Price one year later (yield = 2%): 1,141.40 (1.02) 1,000 (1.02) 0.02 1 0.02 1 50 PV 5 5 = + × - × = Rate of return = [$50 + ($1,141.40 – $1,108.34)]/$1,108.34 = 7.49% 12. a. We know that g, the growth rate of dividends and earnings, is given by: g = plowback ratio × ROE = 0.30 × 0.25 = 0.075 = 7.5% We know that: r = (DIV 1 /P 0
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