Questions 1 and 3 will require Excel, so submit an Excel file that shows your computational steps as a separate file in addition to your Word file.
Question 4 is purely conceptual, no computations are necessary but make sure to apply and reference concepts from the reference below .
- Suppose you buy a bond that will pay $1000 in ten years along with an annual coupon payment of $50 and the interest rate is 4%. Answer the following questions:
- What is the value of this bond?
- Now suppose the bond has no coupon payments (it is a “zero coupon” bond) but still pays $1000 in ten years. What is the value of this bond?
- What would happen to the value of the bond if the inflation rate unexpectedly goes up? What the bond value increase or decrease?
- Now suppose the bond still pays an annual coupon of $50 but the interest rate drops to 2%. What is the new value of this bond?
- The XYZ Corporation pays a dividend of $1 for each share and its required rate of return is 8%. Answer the following questions:
- Assuming zero growth in dividends, what is the value of each share?
- Now assume a 4% annual growth rate in the dividend paid. What is the value of each share?
- Assume the growth rate is still 4%, but the required rate of return drops to 6%. What is the new value of each share?
- this question is attached below
4 Suppose the Alpha Manufacturing Corporation is experiencing extreme financial difficulties and is considering bankruptcy. Its shareholders are currently almost equally divided about whether or not the company should go bankrupt, with one outspoken faction pushing for bankruptcy and the other strongly opposing it. They have $50 million in debt all in the form of bonds, and bondholders are pretty well united in that they want the firm to declare bankruptcy.
- The CEO announces that he is leaning against bankruptcy. This means one faction of shareholders is happy, but another faction of shareholders is very upset and the bondholders are also unhappy. Can the unhappy faction of shareholders team up with the bondholders to vote out the CEO? Explain your reasoning using references from the background readings.
- Suppose Alpha ends up declaring bankruptcy. They do not have any cash in the bank but they own $60 million worth of real estate. They only have one type of shareholder—common shareholders. If they sell the real estate, how much of this will bondholders get and how much with shareholders get? Explain your reasoning using references from the background readings.
- Now suppose that Alpha has two classes of shareholders—common shareholders and preferred shareholders. Preferred shareholders are owed $20 million in dividends that have been unpaid in the last two years. If Alpha goes bankrupt and sells its $60 million worth of real estate, how much will bondholders get, how much will common shareholders get, and how much will preferred shareholders get? Explain your reasoning using references from the background readings.
Subjectmoney. (2013, January 2). How to price/value bonds – formula, annual, semi-annual, market value, accrued interest [Video file]. Retrieved from https://www.youtube.com/watch?v=7zCqoED8MVk
Subjectmoney. (2013, January 3). Dividend discount model (DDM) – constant growth dividend discount model – how to value stocks [Video file]. Retrieved from https://www.youtube.com/watch?v=n76Pz3HOBPo
Ross, S., Westerfield, R., & Jordan, B. (2007). Chapter 6: Interest rates and bond valuation. Essentials of Corporate Finance. McGraw Hill. Retrieved from http://novellaqalive2.mhhe.com/sites/dl/free/007000000x/484691/Part4_Chap6.pdf [If this link is down, click Interest Rates and Bond Valuation for an alternative link.]
Girvin, M. (2010). Stock valuation with dividend growth model. ExcellsFun. Retrieved from https://www.youtube.com/watch?v=cbRIhwkGAnQ
Girvin, M. (2010). Stock value based on present value of future dividend cash flows. ExcellsFun. Retrieved from https://www.youtube.com/watch?v=G2VIY5E3I3s&t=163s
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