FM Worksheet I

YARDSTICK INTERNATIONAL COLLEGE
Master of Business Administration

Course: Financial Management, Semester II Year 2023
Worksheet
1. ABC Company has $1,000 par value bonds outstanding at 9 percent interest. The bonds will
mature in 20 years. Compute the current price of the bonds if the present yield to maturity is:
a) 6 percent.
b) 8 percent.
c) 12 percent.
2. Referring to question 1, assume that interest is paid semiannually. Compute the current price of
the bond under scenario (a) : that means if the yield (discount) rate is 6 percent.
3. Mr. X calls his broker to inquire about purchasing a bond of ABC Corporation. His broker quotes
a price of $1,070. Mr. X is concerned that the bond might be overpriced based on the facts
involved. The $1,000 par value bond pays 13 percent interest, and it has 15 years remaining until
maturity. The current yield to maturity on similar bonds is 11 percent.
a. Do you think the bond is overpriced? Do the necessary calculations.
4. Sam Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 30-
year life when issued and the annual interest payment was then 13 percent. This return was in line
with the required returns by bondholders at that point as described below:
The real rate of return---------------- 7%
Inflation Premium 3
----------------------
Risk premium 5
----------------------------
Total---------------------------------------- 13 %
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected
in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining until
maturity. Compute the new price of the bond.
5. Referring back to problem 4, assume that 10 years later, due to bad publicity, the risk premium is
now 7 percent and is appropriately reflected in the required return (or yield to maturity) of the
bonds. The bonds have 20 years remaining until maturity. Compute the new price of the bond.
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6. The McMillan Corporation paid a dividend of $2.40 per share over the last 12 months. The
dividend is expected to grow at a rate of 25 percent over the next three years (supernormal
growth). It will then grow at a normal, constant rate of 6 percent for the foreseeable future. The
required rate of return is 14 percent (this will also serve as the discount rate). Round to two places
to the right of the decimal point throughout the problem.
a. Compute the anticipated value of the dividends for the next three years (D 1, D2, and D3).
b. Discount each of these dividends back to the present at a discount rate of 14 percent and then
sum them.
c. Compute the price of the stock at the end of the third year (P 3). (HinP 3 =D 4 ____
Ke - g
d. After you have computed P3, discount it back to the present at a discount rate of 14 percent for
three years.
e. Add together the answers in part b and part d to get the current value of the stock. (This
answer represents the present value of the first three periods of dividends plus the present value
of the price of the stock after three periods.)
7. Sterling Corp. paid a dividend of $.80 last year. Over the next 12 months, the dividend is expected
to grow at a rate of 10 percent, which is the constant growth rate for the firm (g). The new
dividend after 12 months will represent D 1. The required rate of return (Ke) is 14 percent.
Compute the price of the stock (P0).
8. A firm pays a $1.50 dividend at the end of year one (D1), has a stock price of $60 (P0), and a
constant growth rate (g) of 8 percent.
a. Compute the required rate of return (Ke).
Indicate whether each of the following changes would make the required rate of return (K e) go up
or down. (Each question is separate from the others. That is, assume only one variable changes at
a time.) No actual numbers are necessary.
b. The dividend payment increases.
c. The expected growth rate increases.
d. The stock price increases.
9. A share has a current market value of 96 cents (c), and the last dividend was 12c. If the expected
annual growth rate of dividends is 4%, calculate the cost of equity capital.
10. The risk-free rate of return is 7%. The average market return is 11%.
( a ) What will be the return expected from a share whose β (Beta) factor is 0.9?
( b) What would be the share's expected value if it is expected to earn an annual dividend of $ 5.3 , with
no capital growth?
WEB EXERCISE
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1. ExxonMobil was referred as a firm that had a low valuation in the marketplace. Go to
finance.yahoo.com and type XOM into the “Get Quotes” box.
Click on the “Profile” section on the home page and write a one-paragraph description of the
company’s activities. Return to the home page and write down the company’s P/E (Price per
earnings) ratio. Is it still relatively low (under 15)? Click on “Competitors” and compare
ExxonMobil to others in the industry based on the P/E ratio.
2. Go back to the home page. Is the stock up or down from the prior day? (See “change” on the home
page.)
3. What is its 52-week range?
4. Scroll down and click on “Analysts Opinion.” What is the Mean Target, the High Target, and the
Low Target? How many brokers follow the firm?
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YARDSTICK INTERNATIONAL COLLEGE

Master of Business Administration

The real rate of return---------------- 7%

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